A man stands behind a security fence at the blockaded Greek finance ministry. If we default, we will be worse off than Bangladesh, said one official yesterday Photograph: Petros Giannakouris/AP

Pressure to inject fresh capital into Europe's weakest banks mounted today as the chancellor, George Osborne, and officials in Brussels united in efforts to prevent contagion from the deepening Greek sovereign debt crisis.

Amid fears that €3.4bn (£2.9bn) of exposure to Greek debt would bring down Franco-Belgian bank Dexia, tensions were rising across the banking sector and pressure mounted on the European Central Bank to be more generous in loans to banks to prevent a rerun of the 2007 credit crunch.

The gloom that has lingered over the banking industry since August deepened further as Germany's biggest bank, Deutsche Bank, warned it would miss its profits target and the cost of insuring major US banks against default reached levels last hit in October 2008.

The share prices of many banks were tumbling as the chancellor and Anders Borg, the Swedish finance minister, urged colleagues to prop up banks with public funds, despite fierce resistance from the French who insist Europe is not at risk.

Senior officials led by Olli Rehn, EU economic and monetary affairs commissioner, backed their stance, which has also been promoted by Christine Lagarde, managing director of the International Monetary Fund. She has said that up to €300bn in capital may be required.

Senior figures are pressing for stress tests for Europe's banks to be brought forward from next year after Dexia passed the July tests with flying colours. Several officials referred to Dexia as "the canary in the coalmine".

Osborne said eurozone banks need to be strengthened. "We need to reflect the reality of the situation in the euro area and account for the reality of the sovereign risk the market can see out there and that requires more capital in some eurozone banks." Fresh capital would preferably be raised privately but a public backstop might be necessary.

Borg, also a non-zone minister, was blunter. "Government support is the best kind of backstop," he said.

Rehn said: "We need to get more firepower against contagion effects and support recapitalisation of the banks."

The head of the European regulator, the European Banking Authority, Andrea Enria, also called for action to fix the eurozone crisis. "It's a major issue that could go from Dexia to other banks, so it's important this is fixed and the sooner it's done the better," said Enria, who oversaw the July stress tests on banks.

Bob Diamond, the Barclays boss, speaking at a London conference, also called on European leaders to be decisive. "Confidence will not be restored until the EU sovereign debt issue is resolved. This is the most critical issue weighing on the markets right now," Diamond said. He called for greater fiscal union in Europe.

Investors are also urging leaders to restore confidence in the banking sector. Robert Talbut, chief investment officer at Royal London Asset Management, said: "The stress tests have once again been shown to have come up short in terms of what investors were looking for. Banks need a forced recapitalisation. It is exactly the right thing to do to rebuild confidence." He said that ideally banks should be split into "bad" and "good" banks and that a eurozone shock would threaten UK banks as well. "If Europe falls over, at least two of the UK's banks and possibly three will need recapitalisation."

The rare spot of upbeat news came from UBS, the Swiss bank hit by the alleged $2.3bn rogue trading scandal, which said it now expected to make a "modest" profit in the third quarter, having said previously warned of a loss. Analysts noted that the reason for the change was the falling price of UBS debt, which, under an accounting quirk, helps to bolster its profits.

At the London conference, UBS finance director Tom Naratil stressed clients had deserted the bank as had been feared and that he expected an improvement in the bank's performance.

At the same conference Stephen Hester, chief executive of RBS, put up a slide saying "return target under review in light of challenges" – referring to the gloomy economic backdrop and the effect of proposals banks should "ringfence" high street form investment banking. RBS shares fell 4% to 21.5p.

Lloyds Banking Group, the other bailed out UK bank, also tumbled as its chief executive António Horta-Osório also painted a gloomy picture. It fell 5% to 32p.

Deutsche Bank warned of 500 job cuts and admitted it would not reach its target for €10bn of profit this year. It was forced to take a €250m writedown. Its shares fell 4%. Pressure is also being felt on banks in the US. Gavan Nolan, director credit research at Markit, noted that the cost of insuring Morgan Stanley and Goldman Sachs hit levels last experienced during the October 2008 crisis.

It now costs $650,000 a year to insure $10m of Morgan Stanley debt and $445,000 to insure debt issued by Goldman Sachs.

Top bankers are hoping the ECB will decide on Thursday to extend credit to eurozone banks from three months to a year, or even two, in an effort to calm tensions.

Evangelos Venizelos, the Greek finance minister, insisted that last night's marathon seven-hour eurogroup meeting had been held in a "very friendly climate towards Greece." The decision to withhold €8bn in aid was a purely procedural matter, he said, taken to give all 17 euro area members the time to ratify the newly expanded European financial stability facility so as not to send the wrong signal to markets.

But Greeks are in shock over the EU's refusal to release fresh rescue funds. In private officials now say the government has enough money to tide it over until November when only weeks ago they were saying it would run out of cash by 15 October.

"When you're negotiating you say such things to speed up the process," one insider said after the press conference.

"The issue is not the sixth tranche of aid but the seventh, eighth and ninth instalments … ministers in Europe are very concerned about contagion. Default cannot be ruled out and that's what Greeks don't seem to realise.

"If we default, it's not just the domino effect. It will make Argentina look like small game. This place will become worse off than Bangladesh. People will be killed for a sandwich as they cross the road. It will be that bad."

Venizelos is first to admit the downward spiral of the Greek economy will continue for some time. It is forecast to contract by 5.5% this year.

"By the end of 2012 the economy will have shrunk by 15% [over four years] … what is important is that we go on to enforce corrective measures, not just fiscal consolidation measures."

Neither Venizelos nor any of his aides have been able to enter their own offices in recent days, such is the fury of protesting civil servants who have taken over an array of ministries including the finance ministry. "They'd beat me up if I tried to go in," one official said.

With the country braced for a 24-hour general strike Wednesday everyone is waiting with bated breath to see if mass rallies turn violent when unions take to the streets.